Jules Renard once said: “I finally know what distinguishes man from the other beasts: financial worries.”
This post continues our list of the Top 10 financial errors we have seen made by smaller law firms. This post concerns the subtle but important distinction between realization of law firm billable hours and the billable hours themselves.
Many firms use billable hours when it comes to performance measures for both partners and associates. In our view, that can be problematic, due to several factors, not the least of which is the ability to write-away time before billing, the write-down of time at billing and the write-off of time after billing.
All of these ‘downsize’ billable time and result in distortions in the financial analysis of the firm if you rely on billable time as a metric in the firm. Instead, we advocate using historical realization rates against billable time to get a better picture of how each lawyer – and the firm in general – is doing from a financial perspective.
With this as our background, our second financial error is:
#2: Relying on Total Billable Hours Rather than Realization Rates to Track Progress.
What is a lawyer’s realization rate? Their realization rate is the percentage of actual income paid to the firm from the billable hours of that lawyer.
For example, Partner X bills 200 hours per month at $200 per hour for a total amount billed of $40,000. Of that amount, 10 hours are written down (taken off the books) for various reasons, and clients pay a total of $30,000. Partner X’s realization rate is 75 percent.
In contrast, Partner Z bills 165 hours at $200 per month, but she has no write-downs, and her clients pay 95 percent of that for a total of $31,350.
Although Partner X bills more hours, because of Partner X’s low realization rate of 75%, Partner Z—with fewer hours billed but with a 95% realization rate – is actually generating more income for the firm.
Your computer-based time and billing program or accounting program should be able to create this report for you. If you determine a historical realization rate for each lawyer, then you can accurately forecast the revenues to be received from their WIP (work in progress).
Examine your results and use it to help guide any discussion of effectiveness and its effect on compensation for partners and associates – as well as the downstream effect on cash flow. Furthermore, once you start reporting on lawyer realization rates, you can start taking steps to tighten them up to make maximum use of all firm resources and hopefully lessen your financial worries.